Adjusting Entries

Adjusting Entries

Adjusting entries are passed in order to comply with accrual basis of accounting. This is to ensure that revenues and expenses are recognized in the accounts in the month to which they relate. These are necessary entries to present a true and fair view of financial information.

These adjusting entries are made just prior to the issue of financial statements that is why they are essential to be adjusted in the unadjusted trial balance. Once the adjusted entries are adjusted in the unadjusted trial balance, the final trial balance comes into existence.

Types of Adjusting Entries

At a broader level, following three types of adjusting entries are common:

  1. Prepayments Entries – refer to the revenue which was received in advance. So, we have to record this as a liability in the accounting.
  2. Accruals Entries – It involves both revenue and expenses. When it comes to revenue, we mean income should be recorded no matter it is received in cash or cash equivalent. On the same side, expenses should be recognized no matter payment is made or not. For example, we record Telephone Expenses to which it relates; no matter it is paid in the current month or the next month.
  3. Non Cash Entries – These include depreciation over fixed assets and provision for doubtful debts over account receivable.

Adjusting entries always involve items of profit & loss (income statement) item as well as balance sheet (statement of financial position) item.

Example # 1

Pass the adjusting entries from the following information:

  1. Depreciation to be charged @ 20{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} over computer fixed assets.
  2. Water expenses bill month of July $1,000 to be paid in August.
  3. Advance rent $20,000 was paid for 02 months of July & August.
  4. Company has taken loan from the bank $100,000. Interest to be charged @ 10{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} p.a.

Adjusting Entries

Date

Account

Debit

Credit

31 July

Depreciation Expense

 

10,000

 
   

Provision for Depreciation

 

10,000

31 July

Water Expenses

 

1,000

 
   

Water Bill Payable

 

1,000

31 July

Rent Expense

 

10,000

 
   

Prepaid Rent

 

10,000

31 July

Interest Expense

 

10,000

 
   

Interest Payable

 

10,000

 

(Though interest is paid annually, we have to record it over every month over accrual basis of accounting.)

 

Example # 2

In order to better understand the concept of adjusting entries, we will take support from another example.

Following transactions relate to ABC:

  1. On 1st January, 2016 ABC acquired a warehouse at a monthly rent of $400. At that date, ABC paid January rent and 06 month rent as security deposit.
  2. ABC has to pay employee’s salary amounting to $2,000 for January but it was paid on 05 Feb.
  3. On 31th January, ABC provided services for clearing the shipment of a client from custom authorities at the port. For rendering its services, it charged the customer $5,000. Accountant has not recorded this into the sales of January. Instead, he assumed it to be the sale revenue of the month of February.
  4. Depreciation to be charged on the assets of the company @ 20 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c}. Fixed asset write down value is 100,000/- on 31st Dec 2016.
  5. Allowance for doubtful debt is to be provided @ 5 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c}. Accounts Receivable figure on 31st Dec 2016 was $50,000.

Solution

  1. To record rent expense for the month of January and recording the security deposit. Remember, the security deposit is part of the current assets of the company and as such it should be shown over the balance sheet in current assets of ABC Company.
 

Debit

Credit

Rent expense

Security deposit

Cash

400

2,400

 

 

2,800

  1. To record employee salary this has not been paid in January. But as per accrual basis of accounting, ABC accountant needs to record as an expense of the month of January. So, he will be crediting accrued salaries to match the debit and credit. Later, when on 05 Feb 2017, ABC will pay employee’s salary, the accrued salary will be debited and cash will be credited as this involves an outflow of cash or cash equivalent.
 

Debit

Credit

Salary expense

Accrued salary

2,000

2,000

On 05 Feb, the following journal entry would be passed in the books of ABC:

 

Debit

Credit

Accrued salary

Cash

2,000

2,000

  1. According to the prevailing generally accepted accounting practices (GAAP), the revenue should be recognized in the period to which it relates. As ABC has rendered its services in the month of January, it should be included in the January revenue. The adjusting entry would be as follows:
 

Debit

Credit

Accounts receivable

Sales

5,000

5,000

  1. Depreciation is charged over the fixed assets of the company to reduce its value as by continuing use, technological obsolescence, wear and tear, fixed assets loses its value. So, in order to present true and fair view, periodic depreciation is charged. The tactic here is to calculate annual depreciation first, then divide the figure by 12 to arrive at month figure of the depreciation. (Monthly depreciation = 100,000 x 20 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} = 20,000 / 12 = $1666.67
 

Debit

Credit

Depreciation expense

Allowance for depreciation

1,666.67

1,666.67

  1. Allowance for depreciation figure is $50,000 on 31st Dec, 2016. Now the accountant has to add the credit sale figure into this figure to arrive at closing figure of accounts receivable which would be 50,000 + 5,000 = 55,000 x 5 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} = $2,750
 

Debit

Credit

Bad debts expense

Allowance for bad debts

2,750

2,750

 

Question & Answer:

Martin is a trader of chemical items sold to various industrial undertaking in the paint sector industries. At the end of the year, there are several transactions which are still unrecorded. They need to be taken into account to make adjustment into the books of account. Following information is available for which, you are required to record adjusting entries:

  1. Payroll accrued 6,000, prepaid payroll 10,000.
  2. There are chances of bad debts on credit sales. There is an bad debt estimation of 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} on accounts receivable.
  3. Interest on long term loan from financial institution 10,000 outstanding.
  4. Unearned revenue 20,000 and unearned realized 14,000 but still outstanding.
  5. Martin withdrew 10,000 cash for personal expenses.

Required:

Being an accountant of Martin, you are required to record adjusting entries so that adjusted trial balance could be prepared.

Date

Particulars

Debit

Credit

 

Payroll expenses

Payroll payable

(To record the accrued payroll.)

6,000

 

6,000

 

Prepaid payroll

Payroll expense

(To record to advance payroll.)

10,000

 

10,000

 

Bad debt expense

Allowance for bad debt

(To record estimated bad debt on receivables.)

4,800

4,800

 

Interest expense

Interest payable

(To record the interest payable.)

10,000

 

10,000

 

Revenue

Unearned revenue

(To record the advance amount received against revenue upon realization.)

20,000

 

20,000

 

Revenue receivable

Revenue

14,000

 

14,000

 

Drawing

Cash

10,000

 

10,000

 

Exercise:

Alan is a sole distributor of the honey brand available in the industry. The following balances have been extracted from the ledger of Alan & Company on Dec 31, 2015.

Head

Debit

Credit

Debtors

160,000

 

Allowance for bad debts

4,000

 

Prepaid insurance

18,000

 

Prepaid rent

40,000

 

Payroll payable

 

24,000

Income from commission

 

30,000

 

Following data is available for making appropriate adjustment on December 31, 2015.

  1. Allowance for bad debt is estimated @ 2 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} of the yearend balance of debtors.
  2. Accrued payroll amounted to $ 30,000.
  3. Commission income for the period $ 38,000.
  4. Prepaid rent on 31 December, 2015 was zero.
  5. Insurance expired for the period 18,000.

Requirement

As an accountant in Alan & Co, you are required to prepare adjusting entries in general journal.

Solution

Alan & Company

Adjusting Entries

Date

Particulars

Debit

Credit

1

Bad debt expense

Allowance for bad debts

To record the estimated bad debt expense. (160,000 x 2 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} + 4,000)

7,200

 

7,200

2

Insurance expenses

Prepaid insurance

To record the insurance expense for the year.

18,000

 

18,000

3

Payroll expenses

Accrued payroll

To record the salaries on accrual basis.

6,000

 

6,000

4

Rent expenses

Prepaid rent

To record the expired portion of the prepaid rent.

40,000

 

40,000

5

Commission receivable

Commission income

To record the accrued commission income.

8,000

 

8,000

 

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